Merkel wants banking union pre-nup

Dangerous exclusion of risky entitiesNo reason to limit European regulation to largest banks

by Gabriel Stein

Thu 28 Jun 2012

One important lesson from the global financial crises is that national bank regulation is insufficient in a globalised world with multinational financial institutions. This is even more so within the euro area, with its single currency and monetary policy. To give them their due, this is broadly realised by euro decision-makers. But, as ever when sovereignty is to be shared and diluted, there is a wide gap between what is desirable and what is available.

In this case, while the French president seems willing to move ahead towards greater bank regulatory integration, the German chancellor is less keen. Merkel is apparently prepared to accept international supervision of Germany's two largest banks; she will not countenance it for the regional savings banks. In terms of a European banking marriage, she insists on what might be called a ‘pre-nup’, excluding some of her assets from the future joint household.

The question is: Why only the largest banks? It is not because they are a greater risk to the German, European or indeed world economy than smaller banks. If anything, the past few years have shown that the distinction between SIFIs (systemically important financial institutions, i.e. too big to fail) and others is meaningless. Any financial institution can be a SIFI, whether it is Northern Rock, Allied Irish Banks, local Spanish savings banks or Royal Bank of Scotland. All it takes is a refusal by politicians to let a bank fail, coupled with some injudicious (at least in retrospect) investments by said bank.

There are probably a number of reasons. As the Financial Times pointed out in mid-June, Germany agrees on the need for a fiscal union in the euro area but says this cannot happen without first achieving political union. France says there needs to be a political union but a banking union has to come first, which throws the ball back in the German court. The Bundesbank agrees on the need for a banking union but insists that the fiscal union must come first.

So one reason for the Chancellor’s stand is that she feels that the necessary conditions for a banking union are not in place. But this still doesn’t explain why only the largest banks should be regulated. A much more likely reason is that regional banks in many countries are still wholly or partly owned by the public sector (again, usually at a local or regional level). This is certainly the case in Germany.

This means that they are as much political as financial institutions, subject to political influence and use. Allowing them to be regulated by a pan-European authority would really mean giving up sovereignty. This would go much further than accepting supranational regulation of banks that are in any case already globalised.But we know that a financial crisis can start in any bank. Banks with public/political backing are no less and perhaps even more likely than large private banks to invest foolishly and recklessly. So Chancellor Merkel’s stipulation is a dangerous exclusion of risky entities. A marriage might be strengthened by a pre-nup. A banking union can only be fatally weakened by it.